Keynes Was Right

Keynes Was Right
By PAUL KRUGMAN
Published: December 29, 2011 686 Comments

“The boom, not the slump, is the right time for austerity at the Treasury.” So declared John Maynard Keynes in 1937, even as F.D.R. was about to prove him right by trying to balance the budget too soon, sending the United States economy — which had been steadily recovering up to that point — into a severe recession. Slashing government spending in a depressed economy depresses the economy further; austerity should wait until a strong recovery is well under way.

Unfortunately, in late 2010 and early 2011, politicians and policy makers in much of the Western world believed that they knew better, that we should focus on deficits, not jobs, even though our economies had barely begun to recover from the slump that followed the financial crisis. And by acting on that anti-Keynesian belief, they ended up proving Keynes right all over again.

In declaring Keynesian economics vindicated I am, of course, at odds with conventional wisdom. In Washington, in particular, the failure of the Obama stimulus package to produce an employment boom is generally seen as having proved that government spending can’t create jobs. But those of us who did the math realized, right from the beginning, that the Recovery and Reinvestment Act of 2009 (more than a third of which, by the way, took the relatively ineffective form of tax cuts) was much too small given the depth of the slump. And we also predicted the resulting political backlash.

So the real test of Keynesian economics hasn’t come from the half-hearted efforts of the U.S. federal government to boost the economy, which were largely offset by cuts at the state and local levels. It has, instead, come from European nations like Greece and Ireland that had to impose savage fiscal austerity as a condition for receiving emergency loans — and have suffered Depression-level economic slumps, with real G.D.P. in both countries down by double digits.

This wasn’t supposed to happen, according to the ideology that dominates much of our political discourse. In March 2011, the Republican staff of Congress’s Joint Economic Committee released a report titled “Spend Less, Owe Less, Grow the Economy.” It ridiculed concerns that cutting spending in a slump would worsen that slump, arguing that spending cuts would improve consumer and business confidence, and that this might well lead to faster, not slower, growth.

They should have known better even at the time: the alleged historical examples of “expansionary austerity” they used to make their case had already been thoroughly debunked. And there was also the embarrassing fact that many on the right had prematurely declared Ireland a success story, demonstrating the virtues of spending cuts, in mid-2010, only to see the Irish slump deepen and whatever confidence investors might have felt evaporate.

Amazingly, by the way, it happened all over again this year. There were widespread proclamations that Ireland had turned the corner, proving that austerity works — and then the numbers came in, and they were as dismal as before.

Yet the insistence on immediate spending cuts continued to dominate the political landscape, with malign effects on the U.S. economy. True, there weren’t major new austerity measures at the federal level, but there was a lot of “passive” austerity as the Obama stimulus faded out and cash-strapped state and local governments continued to cut.

Now, you could argue that Greece and Ireland had no choice about imposing austerity, or, at any rate, no choices other than defaulting on their debts and leaving the euro. But another lesson of 2011 was that America did and does have a choice; Washington may be obsessed with the deficit, but financial markets are, if anything, signaling that we should borrow more.

Again, this wasn’t supposed to happen. We entered 2011 amid dire warnings about a Greek-style debt crisis that would happen as soon as the Federal Reserve stopped buying bonds, or the rating agencies ended our triple-A status, or the superdupercommittee failed to reach a deal, or something. But the Fed ended its bond-purchase program in June; Standard & Poor’s downgraded America in August; the supercommittee deadlocked in November; and U.S. borrowing costs just kept falling. In fact, at this point, inflation-protected U.S. bonds pay negative interest: investors are willing to pay America to hold their money.

The bottom line is that 2011 was a year in which our political elite obsessed over short-term deficits that aren’t actually a problem and, in the process, made the real problem — a depressed economy and mass unemployment — worse.

The good news, such as it is, is that President Obama has finally gone back to fighting against premature austerity — and he seems to be winning the political battle. And one of these years we might actually end up taking Keynes’s advice, which is every bit as valid now as it was 75 years ago.

Across the Atlantic in Europe, a different type of haircut has been debated. The Greek debt crisis is a catastrophic confluence of events. Internal mismanagement and external economic forces have resulted in a recession the depths of which a modern country has never seen. Private creditors (mainly banks) have grudgingly agreed to take a haircut of up to 78% of their debt, but only after they secured a recapitalization plan and only after an agreement was made to use bailout funds almost exclusively to shore up European banks instead of for assistance for the Greek people (read more about that tragedy here and here).

While the Greek government was used essentially as a pass-through to shore up the European banking system against a sovereign Greek default, Greek citizens watched as their social safety net was set on fire:

Greece, one of three eurozone nations to need an international bailout, has cut spending on just about everything it can — public sector salaries, pensions, education, health care and defense. As a result, unemployment has soared to over 21 percent, fueling social unrest that has sometimes turned deadly. In the last two years, riots have erupted frequently and the country's near-daily strikes and demonstrations have shut down schools, airports, train stations, ferries and harmed medical services.
If you ever wondered what Social Darwinism looks like, that's it.

DAVOS, Switzerland (MarketWatch) — Billionaire investor George Soros warned on Wednesday that the austerity Germany wants to impose on other euro-zone nations “will push Europe into a deflationary debt spiral.”

Germans “have been traumatized by inflation and they don’t understand the threat that deflation can cause,” Soros told reporters at the annual meeting of the World Economic Forum in Davos. “There’s a shift in German thinking recognizing this isn’t working, but we’re quite far yet from abandoning this emphasis on inflation as the only threat to stability.”

The euro zone’s sovereign-debt crisis is a major topic this year, with German Chancellor Angela Merkel due to give the opening address this evening and European Central Bank President Mario Draghi set to speak later in the week.

Investors are closely watching talks between debt-laden Greece and private-sector creditors in which the two sides are trying to agree on a writedown of Greek debt that will be voluntary.

“The big issue is how does the euro cope with the danger of a Greek default,” Soros said. “Because that is something that is looming — it may or may not be avoided.”

Soros, an outspoken billionaire and philanthropist, gave a speech on the euro crisis and then took questions from reporters on a wide range of subjects, including China, the U.S., Russia, the Swiss franc and oil prices.

Soros, who has written a new book on financial turmoil in Europe and the U.S., said that measures taken by the European Central Bank in December have relieved the liquidity problems of European banks, but “they did not cure the financing disadvantage from which the highly indebted member states suffer.”

High risk premiums on Italian and Spanish bonds threaten the capital adequacy of banks and leave weaker euro-area nations “relegated to the status of third-world countries that became highly indebted in a foreign currency,” he said.

Instead of the International Monetary Fund, “Germany is acting as the taskmaster imposing tough fiscal discipline,” Soros said. “This will generate both economic and political tensions that could destroy the European Union.”

The billionaire investor said that fiscal discipline alone isn’t enough to solve the crisis and that the EU will have to provide stimulus to get out of the deflationary spiral. “This will require euro bonds in one guise or another,” he said.

DAVOS, Switzerland (MarketWatch) — Billionaire investor George Soros warned on Wednesday that the austerity Germany wants to impose on other euro-zone nations “will push Europe into a deflationary debt spiral.”

Germans “have been traumatized by inflation and they don’t understand the threat that deflation can cause,” Soros told reporters at the annual meeting of the World Economic Forum in Davos. “There’s a shift in German thinking recognizing this isn’t working, but we’re quite far yet from abandoning this emphasis on inflation as the only threat to stability.”

The euro zone’s sovereign-debt crisis is a major topic this year, with German Chancellor Angela Merkel due to give the opening address this evening and European Central Bank President Mario Draghi set to speak later in the week.

Investors are closely watching talks between debt-laden Greece and private-sector creditors in which the two sides are trying to agree on a writedown of Greek debt that will be voluntary.

“The big issue is how does the euro cope with the danger of a Greek default,” Soros said. “Because that is something that is looming — it may or may not be avoided.”

Soros, an outspoken billionaire and philanthropist, gave a speech on the euro crisis and then took questions from reporters on a wide range of subjects, including China, the U.S., Russia, the Swiss franc and oil prices.

Soros, who has written a new book on financial turmoil in Europe and the U.S., said that measures taken by the European Central Bank in December have relieved the liquidity problems of European banks, but “they did not cure the financing disadvantage from which the highly indebted member states suffer.”

High risk premiums on Italian and Spanish bonds threaten the capital adequacy of banks and leave weaker euro-area nations “relegated to the status of third-world countries that became highly indebted in a foreign currency,” he said.

Instead of the International Monetary Fund, “Germany is acting as the taskmaster imposing tough fiscal discipline,” Soros said. “This will generate both economic and political tensions that could destroy the European Union.”

The billionaire investor said that fiscal discipline alone isn’t enough to solve the crisis and that the EU will have to provide stimulus to get out of the deflationary spiral. “This will require euro bonds in one guise or another,” he said.

Austerity backfires in Ireland and Europe - Sinn Fein rise up in polls

Sinn Fein's President Gerry Adams
Photo by AFP/Getty

Sinn Fein’s rapid rise in the polls in Ireland is a clear response to a massive austerity agenda that is backfiring on the current government there.

In an Irish Times poll last week the Sinn Fein vote vaulted into the low 20s, making them the second most popular party in Ireland after the major government party, Fine Gael.

The rapid rise in the Sinn Fein vote is due in the main to the continuing economic tsunami of bad debt and bad news that continues in Ireland.

New rates and water charges have been introduced and the average citizen, already beleaguered by the property collapse and the tight credit, is deeply feeling the effects of the crisis.

Sinn Fein, with a cadre of young front bench spokespersons and a clear attitude of deep skepticism towards Europe, is gaining heavily as a result.

The other main opposition party Fianna Fail, whose profligate policies got the country into the total mess, is understandably receiving very little uptick.

Events elsewhere in Europe will begin to impact on Ireland too. The likely outcome of the French election and the Dutch government collapse are all related to the same reality that the austerity measures enacted by the European Union are proving deeply unpopular and destructive.

Ireland has dutifully followed the German prescription that austerity and more austerity will lead it back to financial stability.

However, cutting wages and raising taxes while creating more unemployment is not the way to build out of a recession.

Deflation is a much more likely outcome of such policies as consumers have less and less to spend and economic growth is impossible to sustain.

The message from Ireland and elsewhere to German Chancellor Angela Merkel is that austerity as a long-term plan is not helping and that stimulus, not cutbacks, are the best way to address the problem.

It is a lesson Germany of all countries should certainly have learned from its own disastrous depression after the Treaty of Versailles which led them into massive debt and eventually led to the rise of Hitler.

There are many such rough beasts out there these days, even here in America, demanding deeper and deeper cuts to spending at the time when the exact opposite is needed in order to survive.

Ireland has remained remarkably calm, with none of the riots that have wracked Greece and Portugal and other countries.

That is to be welcomed, and the hope is that whatever issues arise in the next year or two will be dealt with in a physically non–confrontational way.

A major sea change may be about to take place in Europe over how the entire crisis is dealt with there. Ireland could well be at the forefront of that, a battle over the survival of the Euro and how long-term debt is paid back.

Those patiently following the Greek Bond-Bund spread to its inevitable conclusion have been fully aware that the plan that Europe is betting its entire future on, is patently flawed: namely that austerity, by its definition does not, and will not work. In fact, instead of bringing stability, austerity will slowly but surely eat away at the economy of whatever country it is instituted in - in some cases slowly, in others, like Greece, very rapidly. Indeed, the Greek spread has now risen to levels last seen during the early May near-revolution in Athens, at well over 800 bps. And for the specific consequences of austerity, Germany's Spiegel has done a terrific summary of what it defines as a "death spiral" for the Mediterranean country: "Stores are closing, tax revenues are falling and unemployment has hit an unbelievable 70 percent in some places. Frustrated workers are threatening to strike back. A mixture of fear, hopelessness and anger is brewing in Greek society." Spiegel quotes a atypical Greek: ""If you take away my family's bread, I'll take you down -- the government needs to know that. And don't call us anarchists if that happens! We're heads of our families and we're desperate." All those who think violent strikes in the PIIGS are a thing of the past, we have news for you. The (pseudo) vacation season is over, and millions of workers are coming back. They may not have money, but they have lots of free time, lots of unemployment, and even more pent up anger. Things are about to get very heated once again, first in Greece, and soon after, everywhere else.

http://www.washingtonpost.com/blogs/...g.html?hpid=z2
Romney lets his inner Keyensian out
By Jamelle Bouie
Earlier this year, while campaigning in Michigan, Mitt Romney made the mistake of expressing his inner Keynesian. “If you just cut, if all you’re thinking about doing is cutting spending, as you cut spending you’ll slow down the economy,” he said, earning the immediate scorn of anti-tax conservatives. From that point on, the former Massachusetts governor has been careful to hew to the GOP’s traditional line, reiterating the party’s belief that tax and spending cuts will lead to economic growth and new revenues. But in his recent interview with Time’s Mark Halperin — which you should read in full — he relies on Keynes to show why he wouldn’t commit to deep spending cuts in the first year of his administration:

Halperin: Why not in the first year, if you’re elected — why not in 2013, go all the way and propose the kind of budget with spending restraints, that you’d like to see after four years in office? Why not do it more quickly?

Romney: Well because, if you take a trillion dollars for instance, out of the first year of the federal budget, that would shrink GDP over 5%. That is by definition throwing us into recession or depression. So I’m not going to do that, of course. [Emphasis mine]

Now that Romney is the nominee, I’d be surprised if he received pushback from conservative activists for this rhetorical embrace of Keynesian logic. They may not like it, but they also want to win, and an attack would be counterproductive.

That said, this does raise questions about the dynamic between Romney and congressional Republicans if he’s elected president. Republicans are eager to implement the Ryan plan, and have made it the centerpiece of their domestic policy agenda. Romney is committed to the same agenda, but he also seems willing to pass the Ryan tax cuts and then delay the more radical elements, in order to maintain economic growth (and boost his popularity).

I have no doubt that party leaders and more typical Republicans would go along with this; they’re most concerned with cutting taxes on the rich, and spending cuts or not, I don’t think they would forgo the opportunity. But I can’t say the same for the more ideological Republicans who were elected in 2010, and nearly sparked a second recession out of pique with the administration. They seem to actually believe in the need for radical spending cuts, and it’s unclear whether they would go along with Romney’s plan to push cuts down the road. If the primary against Richard Lugar is any indication, the Tea Party is still unsatisfied with the orthodoxy of the GOP establishment, and its affiliated members might revolt against a package that doesn’t include a significant reduction in the size of government.

Republican House Speaker John Boehner and GOP Presidential nominee Mitt Romney have, in the course of the past week, pushed starkly different approaches to fiscal policy and economic recovery, a window into a broader rift within the GOP between the Tea Party and less absolutist conservatives.

Boehner, carrying the Tea Party line on spending, recently said that he would insist that the deficit be cut by a dollar for every dollar increase in the debt limit, or else he would refuse to raise it, helping drive the country toward default.

"When the time comes, I will again insist on my simple principle of cuts and reforms greater than the debt limit increase," Boehner said.

"Dealing with our deficit and our debt would help create more economic growth in the United States," Boehner told George Stephanopolous Sunday on ABC's "This Week." "The issue is the debt."

Romney, however, said that pushing drastic spending cuts during shaky economic times is a prescription for "recession or depression."

Asked by Time's Mark Halperin Wednesday why he wouldn't push major cuts in his first year, Romney responded with reasoning that would be largely uncontroversial if not for the past two years' mainstreaming of an economic philosophy that insists government spending actually costs jobs, rather than creates job.

"Well because, if you take a trillion dollars for instance, out of the first year of the federal budget, that would shrink GDP over 5 percent. That is by definition throwing us into recession or depression. So I'm not going to do that, of course," Romney said in an answer picked up by former bank regulator William Black, a HuffPost blogger.

Boehner, by contrast, said cutting spending will spur the economy by giving "certainty" to the business community. "It would lift this cloud of uncertainty that's causing employers to wonder what's next. So dealing with our debt and our deficit are critically important," he said.

Any spending cuts, Romney said, should come down the road, after the economy has improved.

"I don't want to have us go into a recession in order to balance the budget," he said. "I'd like to have us have high rates of growth at the same time we bring down federal spending, on, if you will, a ramp that’s affordable, but that does not cause us to enter into a economic decline."

Romney's reasoning accepts the basic premise that government spending adds to GDP and leads to economic growth, at least during times when consumer spending and private-sector demand is down.

The economic assertion is supported by the post-recession job creation numbers. Under President Obama, government spending has grown at its slowest rate since the Eisenhower Administration, according to Politifact. Predictably, that has led to a slower recovery and -- ironically for a president who called for belt-tightening as a political response to the Tea Party -- political trouble for his reelection.

In fact, adjusting for inflation, Obama has actually cut spending by 0.1 percent, according to a Politifact analysis.

While rival schools of economic thought have never agreed on each other's fundamental principles, over the past several decades, the notion that more government spending helps during a recession had gained broad acceptance. But it has been rejected by Tea Party members of Congress and conservative interest groups like the Club for Growth, who have bemoaned Obama's stimulus package and other efforts to boost the economy as job-killing government spending. Club for Growth declined to comment for this article.

The rhetorical thrust of a sharp distinction between the Tea Party's demand for big cuts and Obama's supposed propensity to spend has been a central tenet of the GOP's political messaging over the past two years. And Romney has run afoul of budget-cut purists before, recently over comments he made during a campaign stop in Michigan.

"If you just cut, if all you're thinking about doing is cutting spending, as you cut spending you'll slow down the economy," Romney said, according to MSNBC.

That comment prompted this response from Club for Growth lobbyist Andy Roth: "It's hogwash. It confirms yet again that Romney is not a limited government conservative."

But with Romney now the Republican Party's presumptive nominee for president, anti-government-spending groups are largely holding their fire. Dan Mitchell, senior fellow at the libertarian Cato Institute, told HuffPost that while many at his organization would prefer a "slash and burn" approach to federal spending, they could still accept the "glide path" proposed by Romney -- even if it does rely on "Keynesian" reasoning.

"Big spending cuts would be great," Mitchell said. "So Romney's rhetoric is worrisome. But if he is willing to restrain the growth of spending, so that it grows slower than the private sector, that would be a modest step in the right direction."

House Republicans -- as indicated by rhetoric like Boehner's -- seem less eager to compromise.

UPDATE: A Boehner spokesman said Friday that the speaker also recognizes the value of trimming over the longterm, noting that his recent speech included this passage:

Last fall, when I addressed the Economic Club of Washington, I said that making relatively small changes now can lead to huge dividends down the road in terms of debt reduction. As we approach the issue of the debt limit again, we need to continue to bear this in mind.
As you know, we could eliminate all of the unfunded liabilities in Social Security, Medicare and Medicaid tomorrow, and the effect within the Congressional Budget Office 10-year window could be minimal.

That’s because changes to these programs take time and are phased-in slowly.

For example, when Congress last increased the retirement age for Social Security, the increase – a mere two years – was scheduled to fully take effect 40 years after the law was enacted.

Another example: take the House Budget Resolution and its assumptions for Medicare reform. Those would not even begin until after 2022.